02, Accounting & Financial Analysis

Module: 13, Preparation of Profit and

Loss Accounts Loss Account

Prof. S P Bansal
Principal Investigator Vice Chancellor
Maharaja Agrasen University, Baddi

Prof YoginderVerma
Co-Principal Investigator Pro–Vice Chancellor
Central University of Himachal Pradesh. Kangra. H.P.

Dr. O.P Verma

Paper Coordinator Department of Commerce
Himachal Pradesh University shimla

Dr SS Narta
Content Writer Prof Department of Commerce & Director UCBS
Himachal Pradesh University Shimla
 Module 13: Preparation of Profit & Loss Accounts

1. Aims and objectives

2. Introduction
3. Preparation of profit and loss account:
4. Closing entries for profit and loss account
5. Purpose and Importance of Preparing Profit & Loss A/c
6. Principles
7. Explanation of Important items used in Profit & Loss A/c
8. Summary

Items Description of Module

Subject Name Management

Paper Name Accounting & Finance

Module Title Preparation of Profit & Loss Accounts

Module Id Module-13

Second part of the income statement shows only Indirect

Pre- Requisites
expenses

To understand the Principles of preparing profit of loss

Objectives
Account

Keywords Salaries, Depreciation, Gross loss, Net loss, Interest

Introduction:

The determination of Gross Profit or Gross Loss is done by preparation of Trading Account. But it
does not reveal the Net Profit or Net Loss of a concern during the particular period. This is the second
part of the income statement and is called as Profit and Loss Account. Profit and loss account starts
with gross profit brought down from trading account on the credit side. (If gross loss, on the debit
side). All the indirect expenses such as office and administrative expenses, selling and distribution
expenses and non operating expenses are debited and all the revenue incomes are credited to the profit
and loss account and then net profit or loss is calculated. If incomes or credit is more, than the
expenses or debit, the difference is net profit. On the other hand, if the expenses or debit side is more,
the difference is net loss. This Net Profit or Net Loss is transferred to the Capital Account of Balance
Sheet. Profit and loss account is prepared to ascertain the net profit of the business concern for an
accounting period. In the words of Prof. Carter “Profit and loss account is an account into which all
gains and losses are collected in order to ascertain the excess of gains over the losses or vice versa.”

It shows that only Indirect expenses are taken to Profit & Loss account and deducted from Gross
Profit. Such expenses are of the following types:

(i) Administrative expenses or Office expenses: It includes office salary and wages,
Insurance, Rent, Printing, Postage, Audit fee, law charges, repairs etc.
(ii) Selling and distribution expenses: It includes Salesman’s salaries, travelling expenses,
advertising, discount allowed, bad debts, warehouse expenses etc.
(iii) Financial expenses: These expenses which are incurred for acquiring necessary finances
for the business are called financial expenses. These include: Interest on capital, Cash
discount allowed, bank charges etc.
(iv) Maintenance and depreciation expenses: It includes repair to building, furniture,
machinery, depreciation to building, furniture etc.
(v) General expenses and Losses: It includes loss on the sale of fixed assets, loss by fire,
theft, etc. Fines, Charity, donation and Gifts, Trade expenses etc.
(vi) Miscellaneous income: It includes discount received, commission received, dividend
received, bad debts recovered and income from investments.

DEBIT SIDE

Expenses shown on the debit side of profit and loss account are classified into two categories.

1. Operating expenses and

2. Non-operating expenses

Operating expenses: These expenses are incurred to operate the business efficiently. They are
incurred in running the organization. Operating expenses include administration, selling, distribution,
finance, depreciation and maintenance expenses.

Non-operating expenses: These expenses are not directly associate with day to day operations of the
business concern. They include loss on sale of assets, extraordinary losses, writing off fictitious assets
such as preliminary expenses, underwriting commission etc.

CREDIT SIDE
Gross profit is the first item appearing on the credit side of profit and loss account. Other revenue
incomes also appear on the credit side of profit and to account. The other incomes are classified as
operating incomes and non-operating incomes.

Operating incomes: These incomes are incidental to business and earned from usual business carried
on by the concern. Examples: discount received, commission earned, interest received etc.

Non-operating incomes: These incomes are not related to the business carried on by the firm.
Examples are profit on sale of fixed assets, refund of tax etc.

CLOSING ENTRIES FOR PROFIT AND LOSS ACCOUNT

1. For transferring expenses to profit and loss account:

Profit and Loss A/c Dr xxx

To expenses A/c xxx

[Being transfer of all P&L A/c debit side items]

2. For transfer of incomes to profit and loss account

Incomes A/c Dr xxx

To Profit and Loss, A/c xxx

[Being transfer of Incomes to P&L A/c]

3. For net profit:

P&L A/c Dr xxx

To Capital A/ xxx

[Being net profit credited to capital]

4. For transfer of Net Loss

Capital A/c Dr xxx

To P&L A/c xxx

[Being net loss transferred to capital]

Note: In case of partnership, the profit or loss is divided between partners in their profit sharing ratio
and credited or debited to the individual partners. In case of limited companies, Net profit or loss is
transferred to the P&L Appropriation A/c for disposal.
THE SPECIMEN OF PROFIT AND LOSS ACCOUNT IS SHOWN BELOW

Profit and Loss Account for the year ended 31st March 2015

Particulars Rs. Particulars Rs

To Gross loss b/d xxx By Gross profit b/d xxx

To Office and Administration

xxx By Dividends received xxx
expenses:

Salaries xxx By Interest received xxx

Rent rates & taxes xxx By Income from Investment xxx

Printing & Stationery xxx By Discount received xxx

Postage and Telegrams xxx By commission received xxx

Telephone expenses xxx By Rent received xxx

Legal charges xxx By Profit on sale of assets xxx

Insurance xxx By Sundry revenue receipts xxx

Audit fees xxx By Net loss transferred to capital A/c (Bal. xxx
Fig)

Directors fees xxx

General expenses to Selling & xxx

Distribution Expenses

Showroom expenses xxx

Advertising xxx

Commission paid to salesmen xxx

Travelling Expenses xxx

Bad debts xxx

Provision for doubtful debts xxx

Godown rent xxx

Carriage outward xxx

Upkeep of delivery vans to xxx

Depreciation and maintenance

Depreciation xxx
Repairs to Financial expenses xxx

Interest of borrowings xxx

Discount allowed to abnormal losses xxx

Loss on sale of assets xxx

To Net profit transferred to capita l xxx

A/c (bal.fig)

xxx xxx

Note: *Either net profit or net loss is the balancing figure in P & L A/c

1. The purpose and importance of preparing profit and loss account.

2. To determine the future line of action
3. To know the net profit or loss of business
4. To calculate different ratios
5. To compare the actual performance of the business with the desired one.

Purpose and Importance:

The purpose and the importance of preparing profit and loss account is as under:

1. Knowledge of net profit or net loss: The purpose of preparing profit and loss account is to
ascertain the amount of net profit or loss. This is the actual profit available to the proprietor
and credited to his capital account.
2. Ascertain ratio between net profit and sales: After getting net profit from profit and loss
account. It is matched with the net sale to calculate net profit ratio. This ratio is compared
with the desired net profit ratio and if there is any short coming, that will be removed. This
ratio can also be compared with the ratio of previous years and effective future line of action
can be taken.
3. Calculation of expenses ratio to sale: This ratio can be calculated by compare it with desired
expenses ratio and with the ratio of previous years. It will always be in the interest of the firm
that the expenses ratio should be the minimum.
4. Comparison: The actual performance of the business is available with the profit and loss
account as regards net profit, individual expenses and individual income. We compare our
actual performance with our planned and desired performance, identify weakness and try to
remove them.
5. Maintaining provision and reserves: Certain reserves and provisions are to be maintained to
meet the future uncertainties. The amount of provisions, reserves and funds to be maintained
depends upon net profit earned by the firm. It is necessary to prepare profit and loss account
to determine the net profit, so that effective provision for uncertain future could be
maintained.
6. Determining future line of action: The organization can adopt future line of action on the
basis of the information available from profit and loss account regarding net profit and other
expenses.
PRINCIPLES :

There are certain principles which need to be followed while preparing Profit & Loss Account

 Receipts and expenses of revenue nature should be entered

 Expenses and incomes relating only to the period for which the accounts are being prepared
should be considered if the expense has not yet been paid in cash or the income has not yet
been received in cash.
 All private expenses of the owner and partners must be debited to the capital or drawings
accounts and must not be debited to the profit and loss account.
 Similarly, any income has been earned from the private assets of the proprietor which is
received by firm, it must be credited to the capital.

Explanation of Important items used in Profit & Loss A/c:

1. Salaries: Salaries are paid to employees of the firm working in the office. Salaries paid to
workers of the factory, work manager, production engineer is direct expense so debited to
Trading Account. Salaries and wages means indirect expenditure whereas wages and salary is
a trading item.
2. Rent: Rent of the office, shop, show room etc is an indirect expenses and posted to the debit
side of Profit & loss account. Rent of the factory building shall be, however, charged to the
Trading A/c. the rent received is an income which should be credited to the profit & loss
account.
3. Interest: Interest on loan, bank overdraft, capital etc., is an expense of indirect nature and
debited to profit and loss account. Interest on fixed deposits, investments and loan
advancement by the firm is an income and as such shall be credited to the profit & Loss
account. Interest on proprietor’s drawings should be treated as a separate item.
4. Commission: Commission paid to the selling agents are indirect expenses. It is selling and
distribution expense so it will be debited to profit & loss account. Commission paid to agents
on the purchase of goods is direct expense and posted to the debit side of trading account.
5. Insurance premium: The firm has to pay insurance premium against fire, marine and other
policies. It is an indirect expense; hence it will be debited to the Profit & Loss account.
6. Apprentice Premium: Some firms undertake to train men in various trade, for which they
charge certain fees being called apprentice premium.
7. Life insurance premium: If the insurance premium is paid on the Life policy of the
proprietor of the business, the amount will be treated as his drawings and is shown by way of
deduction from the capital account. It should not be taken to Profit & loss Account.
8. Income Tax: Income tax paid appearing in trial balance of a sole trader is to be treated as an
item of personnel expenses of the proprietor, so it is deducted from capital at the liability side
of balance sheet. It is not debited or credited to Profit & Loss account.
9. Discount: It can be of two types:
(i) Trade discount: It is allowed at the time of selling goods. It is known as off season
discount, new year’s discount, bumper sale and festival discount etc. the amount of
this discount is deducted from sale.(No Special entry is required to be passed)
(ii) Cash discount: It is allowed at the time of making or receiving payments. If the
payment is made immediately or at an early date company may allow its debtors
certain discount.
 10. Loss or gain on sale of assets: There may be loss on the sale of assets, so all losses should be
debited to profit and loss account. It should be noted that loss on sale of asset is not operating
loss. Profit or gain of assets is an income, so it will be credited to profit and loss account. In
case of calculating operating net profit company shall excludes profit on sale of assets from
the credit side of profit and loss account.
11. Trade Expenses: These expenses are also known as sundry expenses, miscellaneous
expenses and office expenses. These expenses are of nominal value, so it is not necessary to
open a separate account for such small expenses, which are generally considered as petty
expenses.
12. Any other loss: Losses are the unwanted burden which the firm may be forced to bear. These
losses may be loss by fire or loss by accident or bad debts etc. These losses will be shown at
the debit side of profit and loss account.

Example

From the following Trial balance of Mr. Rameshwar Swami prepare profit and loss account for the
year ended 31-3-2015.

Office rent Rs. 3000 Salaries Rs. 8,000

Printing expenses Rs. 2,200 Stationeries Rs. 2,400

Tax, Insurance Rs. 1,400 Discount allowed Rs. 600

Discount received Rs. 400 Travelling expenses Rs. 2,600

Advertisement Rs. 3,600

Gross Profit transferred from the Trading A/c Rs. 25,000

SOLUTION

Profit and Loss Account of Mr. Rameshwar Swami for the year ended 31-3-2015
Particulars Rs. Particulars Rs

By Gross profit b/d

To Salaries 8,000 (transferred from the 25,000
trading account)

To Office rent 3,000 By Discount received 400

To Stationeries 2,400

To Printing expenses 2,200

To Tax, Insurance 1,400

To Discount allowed 600

To Advertisement 3,600

To Travelling expenses 2,600

To Net Profit transferred to Capital A/c 1,600

25,400 25,400

Example

From the following Trial balance of Mr. Gandhi prepare profit and loss account for the year ended 31-
3-2015.

Debit (Rs.) Credit (Rs.)

Gross Profit 9,50,000

Commission received 5,000

Interest received 4,000

Sundry income 7,000

Depreciation 10,000

Salaries 15,000

Discount (Dr) 8,000

Discount (Cr) 12,000

Bank charges 4,000

Audit fees 2,000

Stationery 400

SOLUTION
Profit and Loss Account of Mr. Gandhi for the year ended 31-3-2015

Particulars Rs. Particulars Rs

To Depreciation 10,000 By Gross profit b/d 9,50,000

To Salaries 15,000 By Commission received 5,000

To Discount 8,000 By Interest received 4,000

To Bank charges 4,000 By Sundry income 7,000

To Audit fees 2,000 By Discount 12,000

To Stationery 400

To Net profit c/d 9,38,600

9,78,000 9,78,000

Example

From the following balance given below, prepare P&L A/c of M/s. Diviya Ltd. for the year ending

31.12.2015.

Particulars Rs. Particulars Rs

Salary & wages 8,000 Discount allowed 7,000

Interest paid 5,000 Interest received 4,000

Commission received 11,000 Traveling 5,000

Commission paid 6,000 Bad debts 1,500

Advertisement 5,000 Depreciation 10,000

Printing & Stationery 11,500 Other office expenses 1,200

Postage & telegram 7,500 Sundry income 15,000

Rent & rates 1,500 Prov. For doubtful debts 2,000

Medical fees 3,000 G.P. for the year 1,25,000

SOLUTION:
Profit & Loss of M/s Diviya Ltd. for the year ending 31.12.2015

Particulars Rs. Particulars Rs

To Salary & wages 8,000 By Gross profit b/d 1,25,000

To Interest paid 5,000 By Commission 11,000

To Advertisement 5,000 By Sundry income 15,000

To Discount 7,000 By Provision for doubtful debts 2,000

To Traveling expenses 5,000

To Bad debts 1,500

To Depreciation 10,000

To Printing & Stationery 11,500

To Postage & rates 7,500

To Rent & rates 1,500

To Medical fees 3,000

To Other office expenses 1,200

To Net profit 84,800

1,57,000 1,57,000

Example

From the following balance extracted at the close of the year ended 31-03-2015. Prepare Profit and
Loss account of Mr. Santha Kumar as at that date:
Particulars Rs. Particulars Rs

Gross profit 55,000 Repairs 500

Carriage on sales 500 Telephone expenses 520

Office Rent 500 Interest (Dr.) 480

General expenses 900 Fire insurance premium 900

Discount to customers 360 Bad debts 2,100

Interest from Bank 200 Apprentice Premium (Cr.) 1,500

Traveling expenses 700 Printing & Stationary 2,500

Salaries 900 Trade expenses 300

Commission 300

SOLUTION

Profit & Loss Account of Mr. Santha Kumar for the year ending 31-03-2015
Particulars Rs. Particulars Rs

To Carriage on Sales 500 By Gross profit b/d 55,000

To Office Rent 500 By Bank Interest 200

To General 900 By Apprentice Premium 1,500

To Discount to customers 360

To Traveling expenses 700

To Salaries 900

To Commission 300

To Repairs 500

To Telephone expenses 520

To Interest paid 480

To Fire Insurance Premium 900

To Bad debts 2,100

To Printing & Stationery 2,500

To Trade expenses 300

To Net Profit transferred to Capital A/c 45,240

56,700 56,700

Summary:

Net results of an organization can be known by preparing profit and loss account. All the revenue
expenses related to the year whatever it is paid or not and all revenue income related to the current
year, whatever it is received are not must be take into consideration in order to know the exact net
result.

 The profit and loss account is opened in order to ascertain the Net Profit or Loss.
 After the Trading Account is prepared, all other balances on Nominal Accounts remaining in
the Trial Balance are transferred to the Profit & loss account.
 The first item on the Profit and Loss account is a credit by way of transfer of Gross profit
from the Trading Account.
 The transfers of Nominal account balance on Profit & Loss account are made through the
Journal and the entries are called closing entries.
 Closing entries are so called because they serve to close all nominal accounts in the ledger.
 The profit & loss account is finally closed by transferring to net profit or loss to the capital
account of the proprietor.
 The credit balance of Profit and Loss account represents Net profit, and as profit adds to the
capital balance. It is carried to the Credit of the capital account.
 The debit balance represents Net loss, and as loss reduces the capital, the same is carried to
the debit of the capital account.